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Lehman’s Impact on the BDI & Shipping (Then & Now)

September 14th, 2009 Michael McDonough

In retrospect, the widespread panic that engulfed the world’s financial markets after the fall of Lehman Brothers may have been somewhat overblown considering the actual long-term impact of the event, which was significantly mitigated through innovative monetary policy.  But at the time, this did not prevent an almost immediate shut-down of credit markets around the world affecting most, if not all, facets of the global economy.    The shipping sector was no exception.  Within shipping there is an essential financial instrument called a ‘Letter of Credit’ (LOC).   LOCs facilitate the bulk of global trade by guaranteeing the buyer’s funds will be delivered to the seller upon delivery of the goods.  These instruments are issued mostly by financial institutions.

As I mentioned, Lehman’s demise led to an immediate lockup in global credit markets, including LOCs.  To help quantify this I created the chart below, which plots the TED spread against the BDI from 2006. For this application I slightly modified the traditional TED spread and used 3M LIBOR Basis Swap against the Fed Funds rate; this measure acts as a yard stick on implied counterparty risk as LIBOR is the rate at which banks are willing to lend to each other.  You will notice that the unprecedented jump in the TED spread coincides with an extraordinary drop in the BDI from a peak of nearly 12,000 to a low of 663 in only a matter of months.  To help put this into perspective, an article by “The Independent” noted that in June 2008 a shipment of coal from Brazil to China would have totaled US$15mn per voyage compared to US$1.5mn by October, and rates moved even lower from there.

Source: Bloomberg & Capital Link

Source: Bloomberg & Capital Link

Without LOCs, the shipping sector came to what was essentially a standstill. Even where demand still existed, buyers were unable to get the credit to guarantee payments.  A quote from an article in the Financial Post published in October of last year put it best, “There’s all kinds of stuff stacked up on docks right now that can’t be shipped because people can’t get letters of credit,” said Bill Gary, president of Commodity Information Systems in Oklahoma City. “The problem is not demand, and it’s not supply because we have plenty of supply. It’s finding anyone who can come up with the credit to buy.”

How times have changed.  In the year since Lehman’s collapse, credit conditions have improved considerably, as demonstrated by the TED spread, which has begun reverting back toward its historical average.  Better credit conditions have provided increased liquidity allowing buyers around the globe easier access to LOCs.  This alone however does not mean smooth sailing for the shipping sector, but what it does mean is that the sector is highly unlikely to re-test the lows experienced during the end of 2008 and early 2009.

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